SCI-MRT-Research Report_Spring-20

US MRT Research Report
CHAPTER EIGHT:
THE FUTURE OF CRT
Everyone responsible for CRT, in
its various forms, is happy with
what has been achieved and the
current state of the market. Even
relatively disinterested parties
concur that the GSEs have done a remarkable
job in both rehabilitating the reputations
of the organisations and establishing
mechanisms that lessen the burden upon the
US taxpayer.
However, it is worth saying that not everyone
is quite so positive. For example, Malay Bansal,
experienced industry professional, makes a series
of points about the CRT programmes at both
Fannie and Freddie in his well-read blog. There is
a mismatch between the risk transferred and risk
on loans that remain with GSEs, he says.
First, the agencies retain the very bottom portion
of risk in any capital markets or reinsurance
deal, and the first loss might be the right risk to
sell. This, however, could well to be too costly for
the GSEs in terms of yield.
Second, the original STACR and CAS deals
transferred risk on 30-year mortgages only for the
first 10 years, though subsequently increased to
20 years on new deals, after which it reverts to the
GSEs. This leaves a tail risk.
Perhaps most fundamentally, CAS and STACR
were conceived and have been sold during an era of
preternaturally low interest rates. While there is no
immediate prospect of this phase ending, it almost
certainly will do so at some stage. No one has seen
how these notes, or indeed any other post-crisis
MBS, will perform in a high rate environment and
when some mortgages start to default.
More immediately, the future of the GSEs is
in the balance. The end of conservatorship is at
hand. Mark Calabria, appointed to the directorship
of the FHFA in April 2019, has made no
secret of the fact that he wants to return the GSEs
to private hands and says that, all being well,
Freddie and Fannie could be in a position to sell
shares as soon as 2021 or 2022.
In September 2019 the Treasury and the
FHFA allowed the GSEs to increase retained
capital to a combined US$45bn but their leverage
levels are still high. In a speech to the National
Association of Homebuilders in Las Vegas on 23
January 2020, Calabria said, “It [their leverage]
still stands at around three hundred to one. By
contrast, the largest financial institutions in the
nation have an average leverage ratio of roughly
ten to one.”
So, clearly, with or without the doubtless
formidable achievement of the CRT programme,
the agencies still hold far too much risk for
Calabria’s liking. He has also talked of “levelling
the playing field” in the housing market. The
only way forward is to end conservatorship and
approximately US$250bn remaining combined
line of credit to the US Treasury the GSEs currently
enjoy.
Lest we should be in any doubt about the
matter, this is a message Calabria has repeated
in numerous speeches, addresses and interviews
since his appointment. He’s not just speaking
for himself either: it is a theme endorsed by the
national administration.
In September 2019, both the Treasury
Department and the Department of Housing
and Urban Development (HUD) released plans
for the future of the housing finance system. The
Treasury’s plan had 49 recommendations, most
of which had to do with ending conservatorship.
However, in the same document the Treasury
also noted: “The GSEs’ CRT programmes
enhance taxpayer protection and foster price
discovery and market discipline, and in light of
these features, FHFA should continue to support
efforts to expand these programs.”
Further it recommended: “FHFA should,
in prescribing regulatory capital requirements,
provide for appropriate capital relief to the extent
that a guarantor, or a GSE pending legislation,
transfers mortgage credit risk through a
diverse mix of approved forms of CRT.”
“
IF THE GOAL IS TO PRIVATISE
GSES, IT STILL MAKES SENSE TO
DO CRT BECAUSE IT IS CHEAPER
THAN EQUITY
”
Andrew Davidson, Andrew Davidson & Co
Whether Congress possesses the resolution
and commitment to act is a different question,
but what would happen to the CRT programmes
should conservatorship end? Most people believe
that there would be an even bigger role for these
products in that event as they are one of the most
effective and cheapest methods by which the
GSEs can secure new capital.
Neither Fannie nor Freddie will talk about
current political rumblings, the end of conservatorship
and what it means for CRT, but consultants
and market-watchers are bullish. “CRT is
one of the most efficient forms of capital to bear
credit risk. If the goal is to privatise GSEs, it still
makes sense to do CRT because it is cheaper
than equity,” says Andrew Davidson, president
and founder of Andrew Davidson & Co, a New
York-based consultancy.
This is as true for the reinsurance market
as it is for the newer forms of CRT. “When the
GSEs exit conservatorship, they will to have to
raise equity capital – the most expensive form of
capital. To minimise the capital raise, the GSEs
will tap their professional CRT investor and
reinsurer base above and beyond their normal
f low of risk transfer. It makes a lot of sense for
the GSEs and it’s a great opportunity for investors
and reinsurers,” says Jeffrey Krohn, an md at
Guy Carpenter.
Indeed, sources in the reinsurance market
say that private conversations with the FHFA
and other organisations in the centre of this
debate indicate that if anything there will be an
expanded role for the reinsurance market should
the GSEs re-enter private hands.
So, at the very least, it seems there will be a
lively role for mortgage risk transfer well into the
third decade of the twenty-first century.
Analysis for the risk transfer community | structuredcreditinvestor.com/mrtreport2020/
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